Large multi-national companies, or other enterprises, often operate through a number of subsidiary companies, or other legal entities, spread across the globe. These subsidiary companies can be further divided into business units or lines of businesses. The intersection of each subsidiary company and line of business (identified as a “profit center business unit”) can become a supply chain entity that engages in manufacturing, purchase, and/or sale of goods and services.
The profit center business units typically engage commercially with an external supply chain, such as a collection of suppliers and customers. They can also engage in internal trades, or internal transfers, within the subsidiary company. One example type of an internal trade is an “inter-company trade,” where a profit center business unit belonging to one subsidiary company trades with a profit center business unit belonging to another subsidiary company, at arm's length terms and conditions. Another example type of an internal trade is an “intra-company trade,” where two profit center business units belonging to the same subsidiary company trade among each other on a competitive basis. These types of trades typically fall under “management accounting” based performance management, where each profit center business unit is rewarded for the value it adds to the supply chain.
Unlike external transactions, internal trades or transfers are not market-driven. Thus, a transfer price for the internal trade is typically calculated, using methods such as a “cost-plus” method, a comparable uncontrolled price method, a resale price method, a profit split method, etc. Because a transfer price determines the allocation of profit and loss among different entities of a company, and the different entities of the company may fall into different tax regimes, many jurisdictions have implemented transfer pricing regulations and enforcements. This has made transfer pricing a major tax compliance issue for large multi-national companies.
In any supply chain flow consisting of a buy, sell or transfer of goods, the buyer and seller agree upon the event of events when the cost of carrying the goods, risk and the title of the goods are transferred from the buyer to the seller. This may be explicitly agreed upon through a contract, usually using internationally accepted commercial terms. When an event that results in title transfer of goods occurs, it is expected that the seller accounts for the cost, revenue, and receivables in his books of account, and the buyer accounts for the inventory cost and liability for payment in his books. Generally, an invoice is generated, and sent by the seller to the buyer which can become the legal document for accounting and payments.
As the world economy becomes more integrated, company supply chains inherently become more international and complex. As a result, companies often look to less traditional ways to gain supply chain efficiencies. Reducing labor cost, transportation cost, and inventory cost, as well as improving customer service, are always a priority. However, optimizing a financial flow of goods across international markets is an area where companies have significant financial and taxation benefits.
One of the common ways to optimize or reduce costs when distributing goods internationally is to establish a legal entity in a lower tax jurisdiction to centrally buy and sell goods to move them through the supply chain in a tax-efficient manner to the end customer. However, the geographic location of the legal entity often does not fit in the optimal physical flow. The financial flow of the goods typically deviates from the physical flow. While the financial benefit can be significant, enabling this type of distribution model can be challenging due to the increased complexity companies are required to manage.
When distributing goods internationally, companies are careful to consider their operating structure and strategy for physical flow of goods as equally important as the financial flow. A common approach to managing the distribution of goods across multiple companies spread out in different countries is through a principal company, which is established in a lower tax jurisdiction. The structuring of the relationship and terms between the principal company and the local selling companies takes into account a level of added value performed by each party and levels of risk assumed by each party.
Beyond tax savings, companies often look to gain operational efficiencies through centralizing key business functions at the principal company. Some of these types of business functions include: (a) sourcing and procurement—a multi-national company can gain operational efficiencies by centralizing sourcing and procurement and potentially reducing overall spending; (b) customer service—centralizing customer service can help achieve economies of scale while making it easier to present a single face to the customer; (c) demand and production planning—because the principal company is often the main distribution intermediary, it is in a good position to forecast demand and production requirements at an aggregate level; and (d) back office accounting—centralizing accounting functions such as accounts payable and receivables can lower transaction costs and create opportunities for outsourcing.
In addition, companies typically need to identify financial routes for their internal trades/transfers. Further, to support customized trades/transfers, companies also typically require flexibility to use their own information sources to identify a financial route. Such tasks may require that messages be sent to target external systems, in order for the tasks to be executed at the target external systems. Such target external systems can each have different task payload formats.